Inflation Trading Explained

There are two diverging views on inflation for the coming months.

On one side, regulators and major economists expect inflation to be high in the short term, but then level off. On the other hand, there are the dissidents who expect inflation to be high in the short term and stay high going forward.

Nonetheless, both agree that we are currently in a period of high inflation and will continue to be for at least the next few months, if not the rest of the year.

Regardless of the position you may agree with, you could benefit from setting up your portfolio for dealing within a period of inflation.

What can we do?
Currently, hedge funds and big traders have access to a wide range of more sophisticated derivatives. Indeed, they can use these derivatives like tips, to hedge against inflations.

But, what about retail traders and those trading CFDs? Well, there are still many options available to us, to help maximize our returns in a high inflation environment.

Let’s review some of them!

Cash
By definition, inflation means that money loses value.

However, not all money is the same. If we consider the uneven global policy and recovery from covid, forex could be a fantastic opportunity to leverage differences in currencies around the world for profit. This is often known as “inflation arbitrage”.

Also, it’s worth considering your base denomination currency. For example, if the USD has 5% inflation this year, but the yen (virtually) none, then the same trades that give you profit in yen could contribute an additional 5% to your results.

Commodities
Gold is the traditional hedge against inflation.

Nevertheless, because of its “safe haven” nature, it tends to not have as many fluctuations. This means that traders can’t profit from it in the short term. In other words, while gold is generally a good option to prevent value erosion from inflation, it’s not the best option for taking advantage of increased prices.

Aside from gold, there are other commodities we can consider, such as copper, coal, or steel.

In fact, these have moved higher during the recovery period. Not only that, but they also have uses beyond simply being a store of value. Indeed, they could actually provide shorting opportunities if prices get too high, as companies and even governments look for ways to reduce their own raw material costs.

Stocks
Stocks could be an option for getting “the best of both worlds” in an inflation scenario.

Despite this, we need to be extremely cautious when dealing with them. This is because stocks represent real value and therefore resist the erosion of value from inflation.

Moreover, they also generate value on their own through the company’s activities. This means that unlike gold or silver, they will actually appreciate over time. That is if the companies and the economies are properly managed.

Some stocks are dependent on interest rates. This is because their price depends on where traders expect the value of the company to be in the future. These tend to have high p/e ratios and more variance. However, they are more vulnerable to rising interest rates as the central bank tries to control inflation.

Other stocks’ price is dependent on the underlying value of the company. If they have low leverage, they could actually see increased growth from these higher interest rates. That is, if they choose to raise dividends. Based on this, companies with lower gearing could find themselves in a better competitive position in higher interest rate environments.

The bottom line is, historically, higher inflation typically comes with more volatility in the markets. Since it’s less advisable to keep cash, it typically means investors must pay closer attention to what’s going on and stay well-informed to find the best opportunities.